Apple Gives Bears a Snack

You can't say I didn't warn you. I already told you to forget about the iPhone and focus on the iPad. Still, the iPhone segment has the greatest impact on Apple's (Nasdaq: AAPL) results, so the disappointing iPhone sales -- and they were disappointing -- mercilessly weighed on both top and bottom lines.

Let's talk iPhoneiPhone unit sales came in at 26 million, a miss relative to Street analyst expectations of roughly 29 million. This shortfall is the major contributing factor to the top and bottom lines falling short. Revenue came in at $35 billion and net income was $8.8 billion, or $9.32 per share. Investors were hoping for more than $37 billion in sales and $10.33 per share down below.

Source: Earnings releases.

While summers tend to see nice pops in the iPad business after the new models launch, the iPhone slowdown in this case was particularly prominent and wasn't offset by the increase in iPad sales.

The last time Apple "missed" on earnings was fiscal Q4 2011, so this makes two misses within a year. That might make for some fun headlines for bears to snack on, but there's really little to be concerned about here when you dig into the reasons. Just like last time, there was heightened speculation and rumors surrounding the new iPhone model, and this is again the culprit. CFO Peter Oppenheimer said, "Our weekly iPhone sales continue to be affected by rumors and speculation regarding new products."

One notable difference is that last time only one quarter was affected by prospective buyers holding off in anticipation of new models, and this time we'll likely see two quarters with sequential iPhone slowdowns heading into the 2012 model.

In a way, you can also think of this as a function of the magnitude of the upgrade. Apple has taken Intel's (Nasdaq: INTC) famous tick-tock model and applied it to the iPhone, seeing major upgrades every two years and incremental ones in between. Now that the jig is up and buyers now really expect a major 2012 upgrade since the iPhone 4S was incremental, you can expect the effect of delayed purchases to be similarly magnified. After all, if you were planning to buy an iPhone and suspected the biggest upgrade in two years was just four to six months away, wouldn't you wait?

Back to the MacThe same can actually be said about Macs as well. Apple sold a total of 4 million Mac units, also shy of expectations. That represents 2% growth, which while still outpacing the broader PC market that shrank slightly, outpaced by less than normal.

This can also be tied to speculation over new models, as well as context of the year-over-year comparison. CEO Tim Cook mentioned that last year Apple updated its notebook lineup in February, spurring sales throughout the June quarter. In contrast, Apple updated its notebook lineup this year in June with just three weeks left in the quarter. There was also speculation (that turned out accurate) that the notebooks would see the biggest upgrade in several years and would feature Intel's newest Ivy Bridge chips.

Right on cue, Apple unveiled a redesigned MacBook Pro with Retina display and Ivy Bridge processors. On top of that, the first batch of these notebooks sold out quickly, while continued demand subsequently pushed shipping times back to three to four weeks. That pushes those sales into the next quarter. Even now, Cook acknowledged supply remains constrained for these Retina models and expects demand to balance in August.

Something you really have to see. And touch.The iPad was the only area that bested estimates, with unit sales popping 84% to 17 million. Analysts would have been happy with just 15.7 million. The education market for iPads was particularly strong, thanks to the $399 iPad 2, with nearly a million tablets sold to educational buyers. Apple now sells twice as many iPads as Macs to educational institutions.

That $399 price is also putting downward pressure on average selling prices, or ASPs. I fully expected iPad ASP to fall from $559 last quarter to below $550, this figure ended up at $538. The iPad business is now up to nearly $32 billion in trailing-12-month sales.

In the iPad department, it wasn't quite a "blowout," but it was definitely a strong quarter.

The Middle KingdomGreater China continued to boom, with sales in the region jumping 48% to $5.9 billion. iPhone sales in mainland China more than doubled, and Apple didn't launch the new iPad until this month after it resolved its trademark dispute.

Source: Earnings conference calls.

The iPhone strength was partially thanks to adding China Telecom (NYSE: CHA) as a second official carrier in March.

Still cheapOverall, the quarter could have been better, but not meeting analyst expectations doesn't equate to "bad." The fundamental drivers of the business are as strong as ever, and the one product family that really matters at this time of the year shone bright.

Interestingly, Cook dodged a question on moving down market to respond to Google's (Nasdaq: GOOG) Nexus 7, but management is extremely confident in the product pipeline. That pipeline likely includes a smaller iPad Mini and redesigned iPod Touch, and definitely includes a major iPhone upgrade. There's even an off chance we'll see a TV set, but I think that's more likely to be next year.

Piper Jaffray's Gene Munster even expects this fall to see the biggest product upgrade cycle in the "history of man." The short-term reaction will likely be negative, but I see it as a buying opportunity heading into some major product releases. Shares reached as low as $565 in after-hours trading, and backing out the $126.14 in cash puts you at 10.3 times earnings ex-cash.

Pretty cheap if you ask me.

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Good point, as the two share a lot of similarities but they still address different market segments so should remain distinct. The iPod Touch is rumored to also get a larger screen size (4") while the iPad Mini is expected go to smaller (7.85"). That's still a big screen size difference, and each product family still spans very different price points. The iPod Touch goes from ~$200 - $400 while the iPad family (including rumored Mini) would probably be something like ~$250 - $830.

Apple's return on equity is north of 40% (unlevered!). I can't imagine how this rate of return is sustainable in the long run, nothwithstanding the fundamental drivers you cite in your article. At a 40% ROE, it looks like the odds are lining up against this Company.

Finally, keep in mind that the low P/E ratio (sub 14) that the company commands is based on an already high rate of return (the aforementioned 40% ROE). It's a mistake to compare this P/E against a Procter & Gamble that commands a 17 times multiple, as this Company is only generating a 14% return on capital, which is considerably more sustainable in the long-run.

Apple's ROE is actually artificially deflated because it has so much cash on the books, creating a cash drag on ROE.

That actually adds fodder to your argument that its ROE is unsustainably high, since it should be even *higher*, but then as you mention we come back to the fundamental drivers and continued execution.

Apple's low P/E is a little odd, but it shows that at least the broader market somewhat agrees with you and doesn't think it can keep growing as quickly as it is, but the same has been said for the past said for years.

iPhone sales falling off quicker this time than last time is likely (in part) because 4S was not a gigantic leap over 4, so you probably have greater pent-up demand for iPhone 5.

As regarding the iPad, I think nearly doubling iPad sales from previous quarter (9 mill to 17 mill) is a great achievement and one that is not being put into perspective. iPad is penetrating the enterprise and becoming a viable alternative to the PC desktop. It is getting into all sorts of business, from health care to automotive to sales field, etc. What a surprise it will be when Apple sells 30 million ipads next Q.

Then there is China Mobile, which is not a question of if, but simply when. My guess is China Mobile and iPhone 5 are inherently linked.

On the iPad mini, I am still not convinced Apple needs one, nor should they get into the low-margin 7" tablet market. Instead, I'd rather see them know another $100 off iPad 2, and $100 of iPad 3 when they release iPad 4. Then consumers have to make a choice of $250 7" Google tablet (16GB) or $300 10" iPad (16GB). No brainer in my mind.

It's interesting to see that every analyst and news report bar none has said that Apple missed estimates. Well, the truth is AAPL did not miss their own guidance of $34B revenue and EPS (don't remember the exact number but they beat that). The exact same thing happened in 4Q'11 as well. Everybody bashed AAPL for "missing" the estimates (which happened to be only street estimates) when they beat their own guidance. The stock tanked about 7% over a period of about a month before beginning its near 50% ascent.

@ damastr, I was thinking the same thing. Everybody else is just 'guesstimating' and the Apple either blows them out of the water or treads a bit. Apple says they did alright and I believe them; it's their company.

What are other similar companies doing? That's probably too easy to be reported.

"so the disappointing iPhone sales -- and they were disappointing -- mercilessly weighed on both top and bottom lines."

And they were disappointing to only those that invest based on expectations of estimates by random analysts. Without analysts, the iPhone sales were far from disappointing. Any positive is always a positive.